Keeping the list of ETF investments short will keep your portfolio simple without compromising exposure.

Last week I outlined some of the changes happening in the rapidly evolving world of Exchange Traded Funds (ETFs). From two available in the late 1990s there are now more than 230 and counting, and the variety is astonishing with seven ETF providers vying with each other for a competitive advantage.

It is already a bare-knuckle world when it comes to management expense ratios (MERs), the annual fee you pay for ETF management, which start as low as 0.07 per cent. And there are a large number of ETFs with fees under 0.50 per cent. In contrast, MERs for Canadian equity mutual funds average 2.25 to 2.5 per cent.

The burgeoning choice makes for more than a little confusion among investors who wonder how to choose ETFs for their portfolios.

For ETF newbies, the best route is big and simple. By big, I mean broad-based ETFs that mimic or track broad indices such as the S&P/TSX Composite or 60 indices in Canada or the S&P 500 Index in the U.S.

Most investors — neophytes and veterans alike — will be well-served by a single broad ETF for Canada, one for the U.S. and one for bonds. However, you might find disagreement with this approach within the financial services world, which has a multitude of products to sell, covering a variety of asset classes, sectors and countries.

Be warned that while some diversification will improve return, research is clear that over-diversifying hurts return and increases risk.

Another reason for following a less-is-more strategy with ETF investing is simplicity. Take a family with children and both adults employed full-time. Mom and Dad might have one or possibly two workplace pensions of some form, two self-directed RRSPs, two TFSAs, an RESP for the kids and possibly other accounts such as a Locked In Retirement Account (LIRA) from a former employer or non-registered investment accounts. Simplicity has a whole lot going for it to keep things comprehensible.

Even with just two equity ETFs (one Canada and one U.S.) you will still have exposure to other countries. Take earthmoving equipment manufacturer Caterpillar, for example. This multinational company earns 70 per cent of its revenues in countries other than the U.S. So when you buy an ETF tracking an index such as the S&P 500, which contains Caterpillar, you are getting global exposure. Any of the broad-based Canadian or U.S. ETFs will give you significant exposure around the world without cluttering up your portfolio with lots of investment product.

Also, be careful to avoid duplication when investing in ETFs. A reader, Ruth, sent me her RRSP portfolio, which contains two Canadian ETFs: iShares S&P/TSX 60 Index ETF (XIU) and BMO Dow Jones Canada Titans 60 Index ETF (ZCN). But both of these track indices that contain many of the same companies. Yes, she receives a slightly higher yield from the dividend focused ZCN, but the ETFs are too similar to one another. Duplication increases risk in a portfolio.

If Ruth wanted to diversify within Canada, choosing an ETF tracking a distinct index, such as the S&P/Completion Index, with smaller and mid-sized companies would have been a better choice.

Here are some examples of ETFs which give you a piece of the Canada’s largest companies with ticker symbol and management fees (MER) in brackets:

Horizons S&P/TSX 60 Index (HXT, 0.07%)

Vanguard MSCI Canada Index (VCE, 0.09%)

BMO Down Jones Canada Titans 60 Index (ZCN, 0.15%)

iShares S&P\TSX Caped Composite Index (XIC, 0.26%)

PowerShares Canadian Dividend Index (PDC, 0.50%)

When choosing a U.S. equity ETF, also aim for one which tracks a broad-based index — especially if you are new to this kind of investing. If you feel you need multiple investments south of the border then make sure the ETFs are distinct from each other.

Here are some examples of ETFs available, all hedged to the Canadian dollar, which track broad U.S. indices:

Horizons S&P 500 Index (HXS, 0.15%)

Vanguard MSCI U.S. Broad Market Index (VUS, 0.15%)

BMO Dow Jones industrial average Index (ZDJ, 0.23%)

iShares S&P 500 Index (XSP, 0.25%)

Claymore U.S. Fundamental Index (CLU, 0.72%)

ETFs are a great way to invest in equities but they are arguably an even better way to invest in bonds. There is a wondrous variety of ETFs which allow you to hold a basket of bonds for a very small annual fee. Best of all, you can choose from among low-risk, government bond ETFs, those that hold higher returning corporate bonds or ETFs that track an index with both. You can also choose among ETFs holding short, medium and long-term bonds.

Again, less is more. Most investors will be fine with a single Canadian bond ETF. Many experts currently favour short-term bonds with maturities of five years or less, though interest payments will be lower than with ETFs holding longer-term bonds.

Here are some ETFs which offer exposure to the broader Canadian bond market — the PowerShares and BMO ETFs hold both corporate and government bonds.

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